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Posts Tagged ‘contractionary fiscal policy’

Greece lightening?

After a marathon 13-hour session in Brussels, ending at 5am on 21 February, eurozone finance ministers agreed a second bailout for Greece. The aim was to lighten Greece’s debt burden and prevent the country being forced to default.

Under the deal, Greece will have some €107bn of its debt written off. The main brunt of this will be borne by private creditors, who will see the value of their Greek bonds fall by 53.5% (some 70% in real terms). Old bonds will be swapped for ones with longer maturities and lower interest rates. In addition, Greece will be given further loans of more than €130bn through the EFSF on top of the €73bn already lent. The monies will be put in a special escrow account and can be used only to service the debt, not to finance general government expenditure.

In return, Greece must reduce its debt to GDP ratio from the current 160% to 120.5% by 2020. It must agree to continuing tight austerity measures and to significant supply-side reforms to reduce the size of the public sector and increase efficiency. Implementation of the measures would be overseen by an EU Task Force based in Greece.

But while governments in the EU and around the world are relieved that a deal has been finally agreed and that Greek default seems to have been averted – at least for the time being – the problems for Greece seem set to get worse. The further austerity measures will deepen the recession, now in its fifth year. Growth is not expected to return until 2014 at the earliest, by which point real GDP is expected to have shrunk by some 17% from the start of the recession. The question is whether the Greek people will stand for further cuts in income and further rises in unemployment, which had reached 20.9% in November 2011 and is still rising rapidly.

Eurozone backs Greek bailout Euronews (21/2/12)
Greece Wins Second Bailout as Europe Picks Aid Over Default Bloomberg, James G. Neuger and Jonathan Stearns (21/2/12)
Eurozone agrees second Greek bail-out Financial Times, Peter Spiegel and Alex Barker (21/2/12)
Greece secures bailout to avoid debt default Independent, Gabriele Steinhauser and Sarah DiLorenzo (21/2/12)
EU tells Greece to cut more jobs, sees 2014 growth Reuters, Gabriele Robin Emmott and Nicholas Vinocur (21/2/12)
Eurozone agrees €130bn bailout for Greece The Telegraph, Bruno Waterfield (21/2/12)
Greece averted nightmare scenario – finance minister BBC News (21/2/12)
Greece: Dangerous precedent? BBC News, Robert Peston (21/2/12)
The end of the marathon? The Economist, Charlemagne’s notebook (21/2/12)
What Analysts Think of the Greek Deal The Wall Street Journal, Alexandra Fletcher (21/2/12)
Three steps to a strong eurozone Guardian, Henning Meyer (21/2/12)
Opinion: the eurozone is just buying time Deutsche Welle, Henrik Böhme (21/2/12)
Greece must default if it wants democracy Financial Times, Wolfgang Münchau (19/2/12)
Eurozone’s Greece deal: debt and delusions at dawn Guardian. Editorial (21/2/12)
€130bn plaster leaves Greece independent in name only Guardian, Larry Elliott (22/2/12)
The Greek debt deal: Thumbs down The Economist, Buttonwood’s notebook (21/2/12)

Webcasts and podcasts
Are Greeks’ euro days numbered? Channel 4 News (21/2/12)
Wolf and Authers on Greece Financial Times, John Authers and Martin Wolf, (21/2/12)
Greece ‘unlikely to meet targets’ BBC Today Programme, Ngaire Woods, Guntram Wolff and Alistair Darling (21/2/12)
Austerity-hit Greeks scorn bailout deal Euronews (21/2/12)
Greek Bail Out Could Lead To More Violence Sky News (21/2/12)

Official Press Release
Eurogroup statement Europa Press Release (21/2/12)


  1. Outline the features of the bailout on offer to Greece. What is Greece expected to do in return for the bailout?
  2. To what extent has the deal lightened Greece’s macroeconomic problems?
  3. Why does granting a bailout create a moral hazard? How has the ECB/IMF/EU Commission Troika attempted to minimise the moral hazard in this case?
  4. Has Greece’s financial problem been essentially one of liquidity or solvency?
  5. What supply-side measures is Greece being required to implement? Will they have any demand-side consequences?
  6. From where is Greek growth likely to emanate after 2014?
  7. What are the downside risks of the deal?
  8. How likely is it that there will have to be a third bailout?
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Light at the end of the tunnel – or an oncoming train?

Economists are famous for disagreeing – as, of course, are politicians. And there is a lot of disagreement around at the moment. George Osborne is determined to cut Britain’s large public-sector deficit, and cut it quickly. This, argues the Coalition government and many economists, is necessary to maintain the UK’s AAA sovereign credit rating. This, in turn, will allow interest rates to be kept down and the international confidence will encourage investment. In short, the cut in aggregate demand by government would be more than compensated by a rise in aggregate demand elsewhere in the economy, and especially from investment and exports. By contrast, not cutting the deficit rapidly would undermine confidence. This would make it more expensive to borrow and would discourage inward investment.

Not so, say the opposition and many other economists. A contractionary fiscal policy will achieve just that – an economic contraction. In other words, there is a real danger of a double-dip recession. Far from encouraging investment, it will do just the opposite. Consumers, fearing falling incomes and rising unemployment, will cut back on spending. Businesses, fearing a fall in sales, will cut back on investment. Economic pessimism, and hence caution, will feed on themselves.

So who are right? The first two blogs by Stephanie Flanders, the BBC’s Economics Editor, look at the arguments on both sides. The third attempts to sum up. The other articles continue the debate. For example, the link to The Economist contains several contributions from commentators on either side of the debate. See also the earlier posting on this site, The ‘paradox of cuts’.

The case for Mr Osborne’s austerity BBC News Blogs, Stephanomics, Stephanie Flanders (7/9/10)
The case against Mr Osborne’s austerity BBC News Blogs, Stephanomics, Stephanie Flanders (8/9/10)
Austerity plans: Where do you stand? BBC News Blogs, Stephanomics, Stephanie Flanders (10/9/10)
Are current deficit reduction plans likely to boost growth? The Economist debates, various invited guests
Debt and growth revisited Vox, Carmen M. Reinhart and Kenneth Rogoff (11/8/10)
Leading article: Mr Osborne should prepare a Plan B Independent (13/9/10)
Shock fall in UK retail sales adds to fears of double-dip recession Guardian, Larry Elliott (16/9/10)
Chancellor accused of £100bn economic growth gamble by Compass Guardian, Larry Elliott (18/9/10)
Double-dip recession: bulls and bears diverge over future economic prospects Guardian, Phillip Inman (16/9/10)
Speech by Mervyn King to TUC Congress TUC (15/9/10)
Barber, Blanchflower and the fake debate on double dip The Spectator, Ed Howker (14/9/10)

Confidence data
Consumer confidence Nationwide
ICAEW / Grant Thornton UK Business Confidence Monitor (BCM) ICAEW
Business and Consumer Surveys Economic and Financial Affairs, European Commission


  1. Summarise the arguments for the Coalition government’s programme of rapidly reducing the public-sector deficit.
  2. Summarise the arguments against the Coalition government’s programme of rapidly reducing the public-sector deficit.
  3. What factors are likely to determine whether there will be a double-dip recession as a result of the austerity programme?
  4. Why is it very hard to predict the effects of the austerity programme?
  5. How effective is an expansionary monetary policy likely to be in the context of a tightening fiscal policy?
  6. How important are other countries’ macroeconomic policies in determining the success of George Osborne’s policies?
  7. How similar to or different from other recessions has the recent one been? What are the policy implications of these similarities/differences?
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